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Microfinance in India A. Background Since independence, a variety of government schemes have been initiated in India to improve access to credit for the rural poor. In particular, the introduction of special credit programmes and the expansion of the banking sector were intended to make the financial system responsive to the needs of small and marginal farmers, landless labourers, rural artisans and other economically active poor. From 1977 until financial liberalisation in 1990, the Indian banking network saw a rapid expansion under the initiative of the central bank, the Reserve Bank of India (RBI). The RBI had mandated that commercial banks could only open a branch in developed areas if four branches were opened in locations with no bank branches. The bank expansion programme resulted in an extensive branch network, which is unparalleled in other countries. The Indian rural and semi-urban banking network today is made up of about 33,000 branches of scheduled commercial banks, 14,500 branches of regional rural banks (RRBs), over 12,000 branches of district level cooperative banks and 92,000 primary agricultural cooperative societies. Semi-formal and formal financial services are available within less than 5 km for about 99% of the Indian population (Kropp & Suran, 2002). The provision of credit to the poor is further promoted by the requirement that commercial banks must direct at least 40% of their credit portfolio to priority sectors (including agriculture and allied activities as well as small, cottage and village industries). Moreover, 10% of their loan portfolio must be provided to weaker sections of society, including scheduled castes and tribes, small and marginal farmers, agricultural labourers or rural artisans (NABARD, 2004).

Despite the unique outreach of the Indian banking network and the existence of a variety of credit schemes, the financial needs of the rural poor remained largely unmet by the formal financial system. Since the bulk of bank lending was for agricultural purposes, landless labourers, artisans and the assetless poor were still largely neglected by the formal financial sector and small loans for business purposes were often not available. Some schemes were predetermined and could not be modified to the needs of borrowers. As in many other developing countries, the subsidised loans provided resulted in significant losses. Low interest rate margins forced banks to cut down on appraisal and monitoring costs (NABARD, 2004). Loan recovery of regional rural banks was 56% of amounts due in March 1996 (Robinson, 2001). Although RRBs have been successful in mobilizing savings, these deposits were often on-lent to larger borrowers in urban areas, shifting liquidity from rural to urban areas. In the early 1990s, it was estimated that between 35% and 40% of rural households in India continued to depend on informal sources of credit (NABARD, 2004). The failure of government credit programmes raised a need to find more viable mechanisms for administering small loans to the rural poor.

© United Nations Industrial Development Organization


Today, three main models of microfinance can be identified in India: (a) the Grameen model, which is based on the methodology pioneered by the Grameen Bank in Bangladesh; (b) the cooperative model, in which cooperative societies provide credit and savings services to their members and (c) the SHG model (L.B. Prakash, 2004). The SHG model consists of linking so-called self-help groups (SHGs), comprising between ten and twenty poor members, to existing financial institutions. The strength of the model is that it uses the existing network of banks which are legally allowed to mobilise savings rather than having to rely on newly established specialised microfinance institutions which are slow and costly to develop and whose capability and financial strength is not guaranteed.

With its equal emphasis on credit and savings, the SHG model has evolved into the main microfinance model in India. Due to its importance to the Indian context and the potential synergies with UNIDO’s pilot cluster projects in India (see section 3C), the SHG model will be the form of microfinance provision focused on in this paper13.

B. The SHG-Bank Linkage Programme Following an action research project by the National Bank for Agricultural and Rural Development (NABARD) and the NGO Myrada in 1987 and a pilot phase in 1992, the SHG-Bank Linkage Programme was mainstreamed as a normal banking activity in India in

1996. The programme was supported by the Reserve Bank of India. RBI allowed savings accounts of informal groups to be opened by the formal banking system, gave appropriate guidelines to banks to take up the programme and classified SHG-lending as priority sector lending for commercial banks, RRBs and cooperative banks.

NABARD’s vision in 1998 was to provide access to finance for one third of the rural poor through the SHG-Bank Linkage Programme by linking 1 million SHGs by 2008. This goal was met ahead of schedule. By March 2004, banks had cumulatively lent Rs 39.04 billion (USD 860 million) to 1,079,091 SHGs14, providing about 16.7 million poor households with access to the formal banking system. Today, the SHG-bank linkage model is one of the world’s largest microfinance initiative in terms of outreach (Kropp & Suran, 2002).

NABARD is the pioneering agency of the SHG-Bank Linkage Model. It partly finances the cost of SHG promotion, provides 100% refinancing to participating banks and offers revolving fund assistance on a selective basis to NGOs, SHG Federations, credit unions and other organisations providing microfinance for on-lending. NABARD also provides capacity building support to bank officials, NGO staff, government officials and SHG members. In addition to NABARD, several other apex bodies or wholesalers provide loans to financial intermediaries for on-lending to SHGs. These include the Small Industries Development Bank of India (SIDBI), Rashtriya Mahila Kosh (RMK), Housing and Urban Development Corporation (HUDCO), Housing Development Finance Corporation (HDFC) and Friends of Women’s World Banking (FWWB). Some donors and banks (e.g.

Rabobank) also provide grants and loans to microfinance institutions for on-lending to SHGs and SHG federations (Tankha, 2002).

In Sindhudurg, UNIDO has also been working to strengthen cooperative societies.

Nearly 90% of SHGs are women-only groups (NABARD, 2004).

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C. Functioning of SHG-Bank Linkage The main steps involved in the SHG model include group formation, accumulation of group savings, internal lending and on-lending of bank loans.

i) Group Formation SHG formation is typically promoted by external facilitators such as NGOs, banks, government agencies or volunteers15. Once the poor have become convinced of the benefits, they form affinity groups of about ten to twenty members. A similar socioeconomic background of members ensures that they feel at ease and fosters equal participation of members. Since joint savings and internal lending of these savings are important components of the SHG model, the affinity between members is fundamental and it is crucial that members feel they can trust and work with each other.

In a Cluster Development Project in the handloom cluster of Kota (Rajasthan), SHG members emphasised the importance of knowing other members well. However, they pointed out that being related too closely would present problems for peer pressure. In their opinion, they would not be able to do anything if their brothers took the money and did not repay.

During initial meetings, SHG members set rules for the group. It is important that these rules evolve through consensus, that members are aware of the rules and ensure that rules are implemented. Meetings take place regularly at predetermined intervals, e.g. weekly, fortnightly or monthly. Regular meetings foster confidence building among members and improve knowledge of group members.

Members should not join as a condition for receiving a benefit (e.g. access to credit or external assistance), but because they see membership as a means to improve their situation through their own efforts. It is important that groups have a fixed membership and a name to ensure that the group is not a place where people can walk in and out at will16. SHGs can be registered or unregistered. Experience from Bangladesh (Yaqub,

1995) suggests that group formation and cohesiveness of groups has a positive effect on repayment rates at later stages. Special emphasis must therefore be put on group development during the formation stage.

ii) Accumulation of Group Savings Soon after the formation of the group, a savings account should be opened in the group’s name. The SHG authorises three members to operate the account. During each meeting, savings are collected from all members. The group decides on the frequency and amount For more detailed information on forming SHGs, see NABARD’s Handbook on Forming Self-Help Groups, available at http://www.nabard.org/roles/mcid/formingshgs.pdf.

A group’s name often gives an indication of members’ expectations of the SHG. In Sindhudurg and Chanderi, the names of SHGs included “Moral Support”, “Inspiration”, “Freedom Fighter” and “Constitution”.

©United Nations Industrial Development Organization


of savings (or thrift). Monthly amounts saved tend to be small, between Rs 20 and Rs 100 (USD 0.45 – 2.20) per person and are entered into individual passbooks and the group passbook. Regular savings are intended to encourage financial discipline, to provide members with a safe place to save and to build up an internal resource base for the group.

iii) Internal Lending After about two to three months, the pooled savings are used to make small interestbearing loans to members17. Savings and internal lending allow members to meet consumption and production needs and provide training for future larger external loans.

Evidence from Myrada (2000) suggests that in the first year after SHG formation, between 40% and 50% of internal loans are provided for consumption purposes and to release members from moneylenders. At later stages, asset loans become more common. For members, the advantages of borrowing from their group is that loans received can be significantly higher than individual accumulated savings, the amounts required can be negotiated rather than having to accept a pre-determined package, there are no bureaucratic procedures involved, no official guarantors are necessary, and credit is available when needed (Myrada, 1986). The fact that members are simultaneously borrowers and lenders serves as an incentive for repayment. The trust developed through collective savings and internal lending is a crucial component for future joint activities in other areas, such as common production.

Loan proposals, repayment schedules and interest rates are decided upon by the group during meetings and recorded in the minutes book. Good SHGs not only approve loans but also reject some for valid reasons (Myrada, n.d.a). Due to their knowledge of the group members and the environment in which they operate, SHG members are good judges of which business projects are viable.

Experience from UNIDO projects has shown that internal lending is used for both consumption and production purposes. In Kota, internal loans have been used to deal with emergencies and to pay off previous debts. For example, one SHG-member obtained a loan from her group to pay for her husband’s operation who had had an accident. In another group, a woman borrowed the entire group fund of Rs 20,000 (USD 440) in order to pay off a mortgage. She realised that with the savings on interest rates, she would be able to install a loom and increase her income. The group negotiated that her land titles be used as collateral.

In Sindhudurg, three members of an SHG took a joint loan from their group to produce goods to be sold during the Ganesh Festival and for agricultural production. A member from another SHG took out a loan to buy a rickshaw for her husband. Another member used her loan to set up a grocery stall for her husband. In a third group, a member took out a loan to pay for her son’s wedding. Other activities financed through internal loans included trading in cashews, poultry rearing, setting up shops, the purchase of a sewing machine and housing improvements. SHG members said that if the loans could not be repaid, they would seize the defaulting borrower’s goats.

SHGs are thus a form of Accumulating Saving and Credit Association (ASCA).

–  –  –

iv) On-Lending of Bank Loans After about six months, bank staff visit groups and grade them on their performance. SHG assessment differs considerably from that of individuals. Whereas individuals are evaluated on the quality of their projects or their ability to provide collateral, SHGs are assessed on group dynamics and group performance. Grading criteria include frequency and attendance of group meetings, enforcement of rules, maintenance of books, regularity of savings and utilisation of savings for internal loans. If found to be satisfactory, groups can obtain loans or overdraft facilities from financial institutions - typically up to four times the group’s common fund18. Loans are made to the group, not to individual members. All members are jointly liable for loans provided to the group, which are used to supplement the group’s internal funds for on-lending to members. For most SHG members, this is the first time in their lives that they have access to formal loans.

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